INTRODUCTION AND OPERATING BACKGROUND PROPOSAL FOR A VOLUNTEER FIRE DEPARTMENT Raven's Head Ranch (RI IR) was a private, gated community The community had fire protection through the Inise of 300 scattered homes on 1,800 mountainous acres located fire department, which was located three miles from the approximately five miles to the northeast of Boise, ID. The gatehouse for which community members paid a yearly main road to RIIR extended eight miles to the top of the fee. The fee was collected through the Metropolitan mountain and was the only way in and out of the ranch. District (locally referred to as the "Metro"), a governmental Individual homes were situated along this main mad or body organized by public election and subject to state and along the 24 miles of unpaved secondary and tertiary mads. county statutes, regulations, and reporting and auditing RIIR also had two small physical facilities: a small office requirements. All members of the Metro were volunteers. and meeting room at the top of the community and the In late 2007, two RIIR Bol members Preston, the gatehouse, which was staffed by a part-time employee. sitting president, and Gerry-presented a proposal to the The community was self-governed by volunteers who Metro to establish a supplementary RIIR fire department. served on a seven-member board of directors (Bol)) and on the After studying the proposal, the Metro concluded that, "a Finance, Maintenance, and Social commitices. Community Raven's Head Ranch fire department should not be pursued members approved the yearly budget and voted for new at this time for...(three) reasons." First the Metro cited the Ball members at the March meeting, RI IR's members as extremely high cust (approximately $1.5 million) to cover a whole were fiscally conservative and tried to avoid large payments for a salaried fire chief, a maintenance building. expenditures. The Bold oversaw RI IR employees: Sam, a full- fire protection vehicles, and protective clothing and tools, time community manager who also worked on and oversaw hut the cost wasn't realistic to raise from member dues and the road crew; Mable, a part-time volunteer office manager and assessments. Second, the department would still require bookkeeper, and a part-time employee at the gatehouse. Jason, unpaid volunteers to serve as firefighters. Third, even with who was a practicing certified public accountant (CPA) in a local the establishment of a fire department, insurance premiums accounting firm, was the head of the Finance committee and wouldn't be lowered, or the reduction would be relatively oversaw community financial matters. minor in comparison to the large increase required in dues. Each year, two or three new members began three-year In spite of this, five months later Preston and Gerry terms on the Hold. This ensured that there was always a presented a revised plan to organize an RIIR volunteer majority of experienced Bol members to assure continuity. fire department (VFD), which proposed hiring a 30-hour The Bold president was selected by Bold vote from the per week paid fire chief and a paid deputy, purchasing returning members at the first meeting after the March and maintaining an emergency fire truck, and constructing elections. a building to house the fire truck. Gerry would be thefire chief, and Preston would be the deputy. "The only CONCERNS IN THE COMMUNITY OVER THE substantive change in the plan was in specifically calling it VOLUNTEER FIRE DEPARTMENT i volunteer fire department. 'This proposal was submitted to RI IR residents at the March annual election and was As these events unfolded toward the end of 2008, defeated by a vote of 63 to 20. community members were becoming increasingly concemed Despite the community's rejection of the proposal, Gerry, with the turn of events producing the unapproved VID and Preston, and a few other community members pressed its related expenditures. In spring 2009, Gerry, Preston, and forward in planning for a VID. They decided that all fire a third supporter of the VID had intended to run for re- department members would serve strictly as volunteers election as their terms were expiring. Three other residents with no paid members. In June 2008 (three months after the decided in run in opposition, which was the first time in annual meeting), Preston and Gerry called a special town hall which there were more candidates than available positions. meeting to again discuss the establishment of a VID. With The three candidates, Luke, Rich, and Averill, posted the current plan, the Metro encouraged RIIR to consider and mailed flyers specifically pledging to support fiscal the idea of a VID as supplemental fire protection. No responsibility and restore transparent decision making. community vote was taken to approve what was presented as The 2009 annual election saw the largest turnout in RIIK simply "a discussion." community history, with emotions running high; divisive "Two months later, the Bol approved the purchase of factions had obviously emerged in the normally cooperative emergency radios to support the unapproved and nonexistent community. Luke, Rich, and Averill were all elected, VFD. The minutes from that meeting stated: "The Raven's replacing the pro-VID candidates, and Lisa, who had been Head Ranch Bol discussed the purchase of the emergency on the BioD for a year, was voted as president of the Bol. radios to support the volunteer fire department. A check was As president, Lisa had access to documents and written to the Metro district from the Raven's Head Ranch community records that she had never seen before. As she homeowner's association] in the amount of $14.07650 at the read through these documents, she found possible evidence meeting." Concurrently, Preston announced at this meeting of fiscal activities that were disturbing, possibly unethical, and that the expanding Boise fire department had donated one potentially illegal. First, the office manager, Mable, who was of its smaller fire trucks to the RIIR VID). The fire truck was responsible for writing checks for RI IR purchases, had been eight years old and was in very good shape. instructed several times by Sam to write checks for unknown Over the next several meetings, Preston and Gerry items and in amounts greater than she was authorized to presented plans for a Shelter-in-Place (SiP) emergency write without additional approval. Sam wasn't a resident of structure to be built in the community that would be used RI IK but was a full-time employee charged with community as a temporary shelter by community members in the event maintenance and supervision of all employees of the ranch. of a wildfire. which might cut off the top of the community Preston had recently appointed Sam as a lieutenant in the from rescue. It would also serve to house the donated fire VID, a position Sam said he was "honored to have." truck. The Sil was to be constructed using volunteer labor Second, Lisa uncovered records of many questionable and funding from the RI IR community. Several times during purchases made over the past several years. As she began these discussions Preston only gave the Bio materials and to ask questions about them, Jason, who had been serving information to be voted on at the last minute with no time is head of the Finance committee for the past five years, to read or study the documents. Many of these items were resigned, stating he "could not work with the new Ball." proposals for initiatives and purchases to support the VID. Lisa then appointed her hushand Dave, a retired corporate Although some of the Bold members found these activities auditor, as the new head of the Finance committee. After a disturbing, other Bold members supported the idea of a VFD cursory look at the books, Dave concluded that there was and Gerry and Preston's efforts. These initiatives that slowly sufficient evidence to make it prudent to call for an external and inexorably led to the de facto establishment of a VID audit of the books for the past four years. After bids from were never presented to or voted on by the community after and interviews with three independent auditing firms with the failed vote in spring 2008. experience in nonprofits, a local firm was selected and the engagement began soon thereafter in fall 2009. A timeline of events leading up to this point is presented in 'Table 1.THE AUDIT check writing and approval (panel A) and the actual process used (panel BI). Following the completion of the audit, the auditors wrote Fourth, because so many checks were written and a formal letter to the Bol outlining their findings and approved by the same person who designated the account concerns. They concluded that RIIR's governance and to be charged, it was relatively easy to misappropriate internal controls had a number of material weaknesses. funds from established RI IR accounts to pay for expenses as well as additional significant deficiencies. First, the list for unapproved projects, such as the VID. The auditors of material weaknesses began with significant conflicts of noted that the VID, although still not authorized by the interest. The RIIR Bol, the Metro, and the BIR VFD RIIR community and still lacking community approval were all separate entities serving the same community. for a budget, had been receiving funding from community But several governing members of one entity were also accounts for the past three years. "To determine how apveming members of one or both of the other entities with significant these misappropriated funds were, the scope of the authority to approve disbursements of funds. A number the audit was expanded, and the audit team examined all of these disbursements were made from RIIR's accounts for expenses recorded in the community's accounts for the 2007, the benefit of the Metro and the VID. 'Table 2 illustrates the 2008, and 2009 fiscal years. Fifty separate disbursements overlapping roles for several key individuals. from the community's checking account that paid for goods Second, the audit also uncovered frequent examples and services for the benefit of the RIIR VFD or the Metro of management override of controls. The audit specifically were identified. None of these transactions were properly cited instances in which the community's volunteer treasurer, recorded as such in the financial statements but were Mable, a former bookkeeper, had signed a number of checks instead charged to accounts such as telephone, repairs and for goods and equipment for the benefit of the VID that had maintenance, insurance, equipment, road maintenance, not been recorded as VID expenses, rather they had been administration/overhead, social/recreation committee, and assigned to other, standard community maintenance accounts. office expenses. When questioned by the audit team, Mable had admitted that Many of these misappropriated expenditures were she didn't feel comfortable signing checks that appeared in be approved by the community manager, who had financial coded to the wrong account but was ordered to do so by Sam, authority over both RIIR and the VID. Additionally, other the community manager to whom she reported. misappropriated expenses were also approved by then- Third, although RI IR did have procedures to ensure that president of the Bol Preston, who was also the primary all disbursements were properly authorized and recorded, that person driving the establishment of the VID. The total process wasn't being followed. The approval process called amount misclassified over the three years totaled $40,900. for a four-step process for large checks (greater than $1,000) Because the approximate yearly income from dues for the with multiple approvals (1) invoices or requests for checks RIIR community was $410.000, the mixclassification was more than $1,000 had to be approved by a Bold member, (2) considered to be a material amount by the audit team. "Table the invoice then had to be approved by the vice president of 3 compares reported with adjusted expense's. the Ball: (3) the bookkeeper received a copy of the invoice. Lastly, management override of controls, the failure verified the expense account in be charged, and prepared the to follow established procedure, and misappropriation of check; and (4) the check was signed by two members of the expenses were all enabled by a lack of segregation of duties. Ball. Yet the process actually followed during the audit period Due to the limited number of volunteers in the community, varied in significant ways. First, the community manager many critical duties were combined and assigned to the maintained a separate checkbook for expenses less than $250, available volunteers/employees, without sufficient checks which he could authorize, and for between $251 and $1,000, on the process. While this is not an uncommon problem in which required the treasurer as onsigner. But the audit beam small, volunteer-run orandations, segregation of duties found a check written from this account for $1,871 31 signed specifically for the receipt and disbursement of funds is only by the community manager. Secondly, in practice KHIR especially critical to ensure individual integrity and to allowed the community manager to approve these checks, maintain the internal control system. sign them, and designate the account to be charged without Lisa knew that news of an and it would lead to contention approval. "There had been no attempt by the Bold or the head and confrontation in the community, so she tried to delay of the Finance committee to stop or comect the unauthorized releasing the news until the audit was complete and until approvals. Figure I illustrates the established procedures for she had the report in hand. But she had only partial successin this aim. When the news of the audit broke, Jason. the 5. How does conflict of interest undermine both governance former head of the Finance committee, immediately flew and the control system? back to town from vacation and contacted Mable to talk to 5. The American Institute of Certified Public Accountants her about the audit and what she had told the auditors. (AICPA) Andi Rist and Materiality is Conducting an Awdir DISCUSSION QUESTIONS can be adapted to a system of internal controls by assessing inherent risk, control risk, and detection risk, with total risk being the product of these three measures. Use this 1. Segregation of duties functions as the primary preventive model to assess total risk for Raven's I lead Ranch. control by separating the four functional responsibilities of authorization, recordkeeping, custody, and The Committee of Sponsoring Organizations of the reconciliation. This can be difficult for smaller, volunteer- Treadway Commission (CO50) Internal Control- driven organizations. I low would you segregate duties Integrated Fromewart is widely accepted as the standard at Raven's I lead Ranch? What kind of compensatory model for properly designed internal control systems. controls might you use to reduce risk if you could not The Framework classifies the objectives of the control achieve full segregation among the four functional system into three categories operations, reporting. responsibilities? and compliance. Does the current system of controls 2. Discuss the role and responsibilities of a board of at Raven's Head Ranch address these objectives? I low would you define these objectives for the ranch? directors in implementing an effective system of internal controls. Is the board of directors at Raven's Head Ranch The COSO Framework conceptualizes internal control functioning effectively? Why or why not? as having five components: (1 ) control activities, (2) risk assessment, (3) information and communication, (4) 3. Discuss the role and responsibilities of management in monitoring, and (5) the control environment. Explain implementing an effective system of internal controls. Are the individual managers, officers, and committee these components and how they are present (or missing) at Raven's I lead Ranch. heads at Raven's Head Ranch functioning effectively? Why or why not? 4. Discuss the role and responsibilities of external auditors ABOUT IMA* in implementing an effective system of internal controls. IMA, the asociation of accountants and financial professionals Did the external auditors function effectively at Raven's in business, is one of the largest and must respected associations Ilead Ranch? Why or why not? focused exclusively on advancing the management accounting profession. Globally IMA supports the profession through research, the CMA" (Certified Management Accountant) program, continuing education, networking, and advocacy of the highest ethical business practices IMA has a global network of more than 203,000 members in 140 cuntries and 300 professional and student chapters. Headquartered in Montvale, NJ. USA, IMA provides localized services through its four global regions The Americas, Asia Pacific, Bumpe, and Middle East Africa For more information about IMA, please visit www imanet. org